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Once you have decided to start your own business, one of the first important questions to consider is how you will structure your business. Usually, the most obvious way to do this is to operate as a sole trader. A sole trader business structure is simple to set up, making it the most common structure for new businesses. However, when making a decision, you need to consider whether this structure is approproiate for your current situation, and whether it can support your long term business goals. To help you decide, this article sets out the main advantages and disadvantages to operating as a sole trader and the alternative business structures you may want to choose.

Sole Trader Business Structure

A sole trader is a business run by an individual. If you set up as a sole trader, the law considers that you and your business are the same rather than separate entities. This means that you will completely own and control the business and receive all the income and profits from the business. However, this also means that you are solely responsible for all the debts of the business and are personally liable for income tax from the money your business earns.

For example, suppose your business experiences financial difficulty, resulting in debt. As a sole trader, the law classifies you and your business as the same legal entitiy. Hence, you may be required to pay off any business debts using your own personal finances.

Setting Up as a Sole Trader

Setting up your business as a sole trader is relatively straightforward. You can register for an Australian Business Number (ABN) and use your individual tax file number (TFN) to trade. You will also need to register for goods and services tax (GST) if you expect that your income will be more than $75,000 per year.

If you choose to publically operate your business under a trading name (rather than using your personal name), you should register your chosen business name with ASIC. Furthermore, if you want to have exclusive right to use that business name because it is crucial to your brand, you should register the name as a trade mark with IP Australia.

Tax Considerations

You should be aware of the tax consequences of setting up as a sole trader. Importantly, the law will treat any profits of your business as personal income. Hence, so you must report the business income you earn (after expenses) and pay income tax using your personal TFN. Other tax considerations, include that you:

  • pay the same tax as any other individual; and
  • are entitled to the tax-free threshold if you are an Australian resident.

In addition, you are responsible for your superannuation arrangements. You may be able to claim a deduction for personal superannuation contributions and you must make superannuation contributions for eligible workers you employ.

Advantages of Operating as a Sole Trader

Setting up as a sole trader is very common for people starting a small business. This is because it is by far the simplest and cheapest business structure to establish. Note that there are fewer legal and tax issues since the sole trader structure is inexpensive to set up.

Some other advantages of operating as a sole trader are that:

  • you have complete ownership, control and management of the business. Likewise, you have the freedom to run the business as you wish without the interference of other business partners;
  • there are no specific regulations which apply to sole traders. As a result, your reporting requirements are minimal;
  • you keep any profits of the business after tax plus any money you have gained after tax if you sell the business;
  • tax losses may be offset against any other income you earn (subject only to certain non-commercial loss rules); and
  • as an individual, you are eligible for the 50% capital gains tax discount on the money you have gained from the sale of a capital asset (such as the goodwill component of a business sale) that you have held for at least 12 months.

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Disadvantages of Operating as a Sole Trader

Operating as a sole trader can be very appealing to those starting out. However, it is important to bear in mind the disadvantages of operating as a sole trader.

Most notably, you are legally and financially responsible for all aspects of the business. Consequently, your personal assets are at risk if there is debt or liability and you do not have the option to share debts and losses with other business partners. 

Also, it is crucial to understand that there is limited capacity for growth. A key reason is because you cannot take on other business partners or co-founders using this structure. Consequently, you may miss the ability to share ideas and concerns that you normally can do when running a business with others. Likewise, when attempting to grow and raise capital for your business, you are not able to offer a share of your business to investors. This means that you will need to seek financing from lenders such as banks. 

Another important consideration is that there is no flexibility when planning your tax. This ie because all business income is treated the same as your personal income. Accordingly, the more income your business makes, the more your tax liability increases. Unfortunately, you cannot access flat tax rates such as those enjoyed by companies.

Finally, it is more difficult to change ownership when selling the business. This is because valuable assets such as goodwill are inseparable from you as an individual.

Other Business Structure Options

Other than operating as a sole trader, two common alternatives are entering a partnership or forming a company. We discuss these two options below.

1. Forming a Partnership

In a partnership structure, all partners own the business and its assets jointly. It also means that the partners are equally responsible for debts. Therefore, there is scope to share profits and losses with others involved in the running of the business.

2. Creating a Company

A company is a separate legal entity from you and is regulated by ASIC. This separation gives you an extra level of flexibility in:

  • managing your business affairs;
  • distributing profits; and
  • protecting your assets.

It also reduces your personal responsibility for business debts and other liabilities.

Key Takeaways

Operating as a sole trader can be an attractive business structure because of the flexibility and low administration and set up costs. However, it is important to bear in mind the disadvantages, in particular the difficulties you can face, such as:

  • trying to grow and expand the business;
  • raising finance; and
  • the risk of personal liability for debts of the business.

If you would like help determining whether operating as a sole trader is the best structure for your business, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

Frequently Asked Questions

How do I start a business as a sole trader?

Setting up your business as a sole trader is relatively simple. Firstly, you need to register for an Australian Business Number and use your individual Tax File Number to trade. Secondly, you might choose to publically operate your business under a name that is different from your personal name. In that case, you should register your chosen business name with ASIC and seek to have a trade mark over it. Additionally, will need to register for Goods and Services Tax if you expect your income will be more than $75,000 per year.

What are alternative options to operating as a sole trader?

A popular business structure is working as a partnership. This is ideal if you have one or more partners who are willing to work together towards a common goal. A partnership can be beneficial to share profits and losses with others involved in the running of the business. Alternatively, you can set up a company. While there are more formal requirements involved, like registration with ASIC, a company structure is ideal for large growth.

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